State of the Energy Industry, Petroleum and Natural Gas Issues

Remarks by John Felmy,
Chief Economist American Petroleum Institute
Before the United States Energy Association
2nd Annual State of the Energy Industry Forum National Press Club, Washington, DC January 17, 2006

With the hurricane season past and much, but not all, of the lost Gulf production and refining back on line, oil and gas prices have receded. But no one should conclude that we aren’t facing some tremendous energy challenges ahead. The most recent forecasts of the Energy Information Administration indicate we still haven’t escaped our energy predicament. Their sobering message to consumers: Strong demand, hurricane affected production increases and infrastructure limitations could help keep markets tight and prices volatile for the foreseeable future.

Complicating the overall supply/demand situation is a number of contributing factors. The new federal energy law eliminates the reformulated gasoline oxygen requirement in May, and ultra low sulfur diesel will be introduced starting June 1. The industry is working hard to meet these new requirements, but they are major transitions and will present a challenge that could adversely impact supplies.

So when will there be relief for consumers? What can be done to get us off this treadmill?

The answer is quite simple: increase supply, reduce demand and expand and diversify infrastructure.

In attempting to meet the challenges we face, it is also important to do no harm. The worst thing Congress could do now would be to repeat the mistakes of the past by overriding the structures of the free marketplace. Imposing new controls, allocation schemes, new taxes on industry, or other obstacles will only serve to make the situation much worse, hamstringing the very individuals who are being relied upon to bring our energy systems back to full operating order.

Better understanding of the oil and natural gas industry’s earnings and how they compare with other industries might help discourage some of these bad ideas. The oil and natural gas industry is among the world’s largest industries. Its revenues are large, but so are its costs of providing consumers with the energy they need. Included are the costs of finding and producing oil and natural gas and the costs of refining, distributing and marketing it.

The energy Americans consume today is brought to us by investments made years or even decades ago. Today’s oil and natural gas industry earnings are invested in new technology, new production, and environmental and product quality improvements to meet tomorrow’s energy needs. Oil & Gas Journal estimated that the industry’s total U.S. spending in 2005 was $85.7 billion, compared with $80.7 billion in 2004 and $75.5 billion in 2003. It also estimated that exploration and production spending in the U.S. grew 6 percent and that total upstream oil and gas spending in the U.S. was nearly $66 billion.

The industry’s earnings are very much in line with other industries and often they are lower. This fact is not well understood, in part, because the reports typically focus on only half the story – the total earnings reported. Earnings reflect the size of an industry, but they’re not necessarily a good reflection of financial performance. Earnings per dollar of sales (measured as net income divided by sales) provide a more relevant and accurate measure of a company’s or an industry’s health, and also provide a useful way of comparing financial performance between industries, large and small. 

For the third quarter of 2005, the oil and natural gas industry earned 8.2 cents for every dollar of sales compared to an average of 6.8 cents for all U.S. industry. For the second quarter of 2005, the oil and natural gas industry earned 7.7 cents for every dollar of sales compared to an average of 7.9 cents for all U.S. industry. Over the last five years, the oil and natural gas industry’s earnings averaged 5.7 cents compared to an average for all U.S. industry of 5.5 cents for every dollar of sales.

Policymakers need to focus on increasing supplies and encouraging conservation. The Energy Policy Act of 2005 signals a first step in a much-needed effort to enhance energy security and ensure the reliable delivery of affordable energy to consumers. Nevertheless, much remains to be done.

We can no longer afford to place “off limits” vast areas of the Eastern Gulf of Mexico, off the Atlantic and Pacific coasts, and offshore Alaska. Similarly, we cannot afford to deny Americans consumers the benefits that will come from opening the Arctic National Wildlife Refuge and from improving and expediting approval processes for developing the substantial resources on federal, multi-use lands in the West.

In fact, we do have an abundance of competitive domestic oil and gas resources in the U.S. According to the latest published estimates, there are more than 131 billion barrels of oil and more than 1000 TCF of natural gas remaining to be discovered in the U.S.

Much of these oil and gas resources – 78 percent of the remaining to be discovered oil and 62 percent of the gas – are expected to be found beneath federal lands and coastal waters.

Federal restrictions on leasing put significant volumes of these resources off limits, while post-lease restrictions on operations effectively preclude development of both federal and non-federal resources. Addressing these restrictions is critical.

And, while we must focus on producing more energy here at home, we do not have the luxury of ignoring the global energy situation. In the world of energy, the U.S. operates in a global marketplace. What others do in that market matters greatly.

For the U.S. to secure energy for our economy, government policies must create a level playing field for U.S. companies to ensure international supply competitiveness. With the net effect of current U.S. policy serving to decrease U.S. oil and gas production and to increase our reliance on imports, this international competitiveness point is vital. In fact, it is a matter of national security.

Beyond easing the way for greater development of oil and natural gas, we must also address the nation’s refinery capacity challenge. While refiners have increased the efficiency, utilization and capacity of existing refineries, these efforts have not enabled the U.S. refining industry to keep up with growing demand.

The fact is that – faced with increasingly more challenging fuels regulations – only major refineries have the resources needed to expand their capacity. Smaller refineries are increasingly unable to afford to expand. Moreover, local opposition and not in my backyard (NIMBY) attitudes persist and prevent new refineries from being constructed.

The U.S. refining industry has been expanding at a rate of approximately 1 percent per year over the past decade – the equivalent of a mid-size refinery every year. In order to create the opportunity for increasing the growth of U.S. refinery capacity, government policies are needed to create a climate conducive to investments to expand domestic refining capacity, including streamlining the permitting process to ensure the timely review of federal, state and local permits to expand capacity at existing refineries and reforming new source review requirements.

Conclusion
Addressing the nation’s energy problems is an enormous long-term challenge. But, if we all do our part – industry providing supplies, government increasing access to supplies and facilitating needed approvals, and consumers using less fuel – we can step off the treadmill we’re on to a stabler and more secure energy future.